Exchange Rates to Be Key Issue in U.S.-China Trade Talks

Shi Xianbin has watched with alarm as China's currency has risen against the U.S. dollar, driving his small textile company to slash prices to stay competitive abroad.

Shi, manager of the Shanghai Bin Bin Yuan Import & Export Co., said that if the yuan rises another 2%, his privately owned, 10-employee company will face "lots of losses."

"We cannot survive," he said.

With a critical round of trade talks with Washington opening Tuesday, Chinese leaders are pointing to the potential financial troubles of firms like Shi's in resisting U.S. demands to let the yuan rise faster to trim China's ballooning trade surplus.

The U.S. trade deficit with China, which hit a record $232.5 billion last year, has become a heated political target for both Democrats and Republicans, illustrating what they say are unfair, predatory Chinese trade practices.

Range of Issues

Issues in the talks are expected to range from environmental problems to opening aviation routes and financial services, but the currency dispute is expected to dominate. China's intransigence is worsening an already sour mood in Washington, analysts said, strengthening those who want to punish Beijing if it fails to act.

China & the U.S.

Discussing the options and likely outcome for the China/U.S. trade talks, with John Harwood, CNBC chief Washington correspondent; Krishna Guha, Financial Times chief U.S. economics correspondent and CNBC's Sue Herera

Chinese officials are failing to understand the intensity of anger in Washington and could face a backlash, said Jason Kindopp, chief Asia analyst for the consulting firm Eurasia Group.

"This could lead to a real trade war," Kindopp said. "It happened with our close ally Japan during the '70s and '80s. Why couldn't it happen with China?"

In a move clearly timed to show Chinese flexibility ahead of the meeting, Beijing announced changes Friday to its exchange rate system that could let the yuan rise faster. Authorities said they would widen the daily trading limit to 0.5% above or below the previous day's closing value, up from a 0.3% band.

Still, it wasn't clear whether the limited change was enough to satisfy American critics.

Trying to head off a row, the top Chinese envoy to the talks Wednesday and Thursday has appealed to Washington to be coolheaded.

"Attempts to politicize trade issues should be resisted," Vice Premier Wu Yi wrote in a commentary Thursday in The Wall Street Journal.

Frequent Travel

U.S. and Chinese officials have been traveling to each other's capitals in recent months trying to tee up other issues more likely to produce agreement. But the leader of the U.S. delegation, Treasury Secretary Henry Paulson, has said Chinese action on the yuan--rather than market opening, anti-piracy or other areas--is the benchmark by which he would measure Beijing's progress.

Critics have charged that Beijing keeps the yuan undervalued, some say by as much as 40%, to make its exports cheaper, creating an unfair price advantage that fuels its trade surplus.

Under pressure, Beijing broke a direct link between the yuan and the dollar in July 2005 and revalued the currency by 2.1%. Since then, it has allowed the currency to rise 5.3% against the dollar in tightly controlled trading. Economists expect an increase of 4% to 7% over the course of 2007 under the current system.

Washington is pushing for faster action, saying that the undervalued yuan is contributing to a loss of U.S. manufacturing jobs. U.S. legislators have introduced a bill that would enable companies to seek tariffs on Chinese goods in retaliation for its currency policies, though a similar measure in 2005 failed.

Sens. Charles Schumer, D-N.Y., Lindsey Graham, R-S.C., Max Baucus, D-Mont., and Charles Grassley, R-Iowa, say they are working on a China currency bill and plan to introduce it in June.

Wu, the trade envoy, rejected such sentiments as irresponsible.

"Irresponsible Acts"

"Such irresponsible acts can only obstruct economic globalization and hinder the fundamental interests of both China and the U.S., our peoples and the sustainable and steady growth of the world economy," she wrote.

A rise of 10% in the yuan could lead to the loss of 5.5 million jobs in China, according to a report by the Chinese central bank. It said companies hardest hit would be those that make textiles, furniture, shoes and toys for export.

"If the yuan rises by another 5%, our profits will be totally wiped out," said Li Shaoxiong, deputy general manager of the Fujian Ala Shoe, which sold half its 2006 output of 6 million pairs of athletic shoes to American retailers.

Beijing is counting on such labor-intensive light manufacturers to create millions of new jobs. Even though its bustling economy is expected to grow by more than 10% this year, a big share of that is in heavier manufacturing and other industries that create fewer jobs.

"Overall, this is a political thing. Will some companies suddenly have to close down, and will this cause opposition and political repercussions?" said Yiping Huang, an economist with Citigroup Inc.

Chinese officials have ruled out any sharp revaluations in response to U.S. pressure, insisting at a briefing this week on the Washington trip that such a step might disrupt the economy.

"Need a Balance"

"Companies are all complaining about the yuan appreciation. Both sides are under pressure. We need a balance," said a Finance Ministry official, who spoke on condition he was not identified by name.

Officials at the briefing told reporters that they were frustrated in dealing with a Congress whose members turn local factory closings into international trade disputes.

There is a "massive misunderstanding" between Beijing and Washington that has left China believing "political theater" that produces no firm agreements next week will defuse tensions, Kindopp said.

"I think that Wu Yi and her team have not been fully briefed from her own underlings on the rising political pressures," he said, "and some of this stuff has taken them by surprise."

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